Wednesday, 13 May 2009

The risks of Obama's financial conservatism

In the Financial Times, Martin Wolf worries that Obama's approach to the economic crisis is too conservative, taking the administration's strategy as primarily to 'get the show back on the road' with reforms in the spirit of Giuseppe di Lampedusa's Sicilian novel The Leopard, "“If we want things to stay as they are, things will have to change".

But Wolf worries about the implications of a system in which institutions remain 'too big to fail' and so where taxpayers remain risk bearers of last resort, as we clearly were through the boom years and the 2008 crash:

Ensuring the rescue of a financial system packed even more than before with complex and “too-big-to-fail” institutions may well be the cautious response to this crisis. But it leaves the government with the even more onerous task of imposing effective regulation in future. Unhappily, the record of regulation of generously insured financial systems is extremely poor. The mobilised self-interest of highly rewarded players easily overwhelms the constraints imposed by far less well-rewarded and almost certainly less able regulators.

The more the crisis unfolds, the more evident it is that incentives in the financial system were (and are) badly distorted. I sympathise with the conservative approach to crises, but not if it leaves in place the plethora of perverse incentives that created them. At the end of this, then, there will be one big test: will the number of institutions thought “too big to fail” be as large as now and, if so, how will they be controlled? If the answers are still not clear, there will need to be yet more change.